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As WE MOVE from welfare-as-we-knew-it to welfare-as-we-have-never-known-it, an often acrimonious debate is continuing between those who contend that the change will be most effective if the beneficiaries are motivated by a carrot and those who favor a stick. The press simplifies the story by calling the carrot people liberals and the stick people conservatives.

Actually, this is a very old debate. It went on during the years of AFDC (Aid to Families with Dependent Children), and it is going on in our time of TANF (Temporary Assistance to Needy Families). Both sides remain supported by innumerable anecdotal or imaginative reports and by many elaborate sociological studies, complete with chi-squares, regression analyses and multicolored graphs.

Welfare has generally been understood to be temporary, because the economic system has conventionally been understood to be evolving toward perfection. AFDC was envisioned as helping both poor widows and deserted mothers through a personal hard time. Many voters were surprised when it appeared that the distress of millions of families was caused by economic hard times that persisted, not only in the big cities but also in the countryside. Many more voters were angered when the late George Wylie’s Welfare Rights Organization and others, including some government officials, worked to inform distressed families of the help available to them. Still more voters became choleric as careless teenage girls and shiftless older women were said. (although the evidence was scanty) to make a living by producing babies while their male friends used welfare checks to tide themselves over when the drug-dealing or car-jacking business was slow. Hence TANF, with its lifetime limitations on welfare benefits, and the other restrictive provisions of the 1996 law, signed by the President amid a show of determination to fix it when he got a chance.

It does not take much imagination to see that little, if anything, has been accomplished. Let us suppose that there are women willing to make babies in order to stay on welfare. How are we going to stop them? We can, to be sure, reduce or cut off their benefits, but their children, who certainly did not originate their own births, will be the ones most hurt, as has happened in starvation situations in all cultures and all times.

Or are we going to turn children out in the streets, copying the culture of Calcutta? Or shall we take the children away from their mothers and put them, as some politician (I forgot who) suggested, in orphanages-preferably, no doubt, orphanages run for profit? What, then, becomes of family values?

Family values, of course, are only a couple of political catchwords that no one bothers to define. Nevertheless, one must wonder what is so important in our civilization that it requires putting children in orphanages or driving them into the street in order to punish the mothers. And will the presumably selfish mothers even feel the pain of the punishment being meted out?

The most enthusiastic advocates on the draconian side of the debate estimate that a high but unspecified percentage of welfare mothers will respond as intended to the stick approach-that they will seek and perform menial labor for substandard wages. This is nothing for civilized people to be proud of.

Assuming the expectation is correct, moreover, we will still have a considerable percentage of women pursuing their procreative ways. We might have their tubes tied, but the Supreme Court is apt to consider this a violation of the Eighth Amendment’s “cruel and unusual punishment” clause. Amending the Amendment is not likely to appeal either to those upholding the Right to Life or to those defending the Right to Choose-which pretty much covers the voting spectrum. On the other hand, there is evidence that the carrot approach sometimes encourages welfare dependency.

As ALMOST ALWAYS happens in sociology, and far too frequently happens in economics, we are asked what is the: most efficient or cost-effective solution. Efficiency and cost-effectiveness, however, are at best secondary aspects where the lives of people are involved. For instance, the drug problem, however you want to define it, is considered one of the most serious facing America today. The vast majority of voters would probably place it ahead of welfare motherhood, and many would list it as a cause of welfare motherhood. Yet there is a recent example of an efficient and cost-effective solution that not even the most absolute American drug hater proposes we adopt.

For more than a hundred years after the Opium War (1839-42), in which the British forced China to allow the importation of opium, China was the typical case of the drug-plagued land. The opium dens of Shanghai and Canton were celebrated in fact and fiction. Mao Zedong’s People’s Republic wiped out the plague almost overnight. It was very simple. Every apartment house or neighborhood or farm had a committee dedicated to uncovering enemies of the people. Drug users and dealers were designated enemies. A few public trials (denunciations, actually) were held in athletic stadiums, followed forthwith by public executions. Other suspects were given the option of quitting cold turkey or being shot. Formal proof was unnecessary; suspicion was enough to trigger the option.

Despite this well-known bit of recent history, we do not rush to emulate it. We refrain for many reasons. The principal reason is that, with us, crimes deserving punishment must be proved in a court of law.

The Chinese solution was effective because judgment was summary and incontestable. That the sentence was capital speeded things up. A lighter sentence would have required more prisons or more chain gangs or more pillories, and especially more time to demonstrate to everyone that this particular crime did not pay. With us, justice is more important than effectiveness, efficiency or expense.

Although you would never realize it from the way we talk or the way we write in our newspapers and magazines and textbooks, justice is also more important to us in economics than is effectiveness, efficiency or expense. Why else should we have abolished (to take the most vivid examples) slavery and child labor? To be sure, we had to fight a civil war to abolish slavery, and it wasn’t until 1938-eight years into the Great Depression that we were able to get a child labor law through a Southern-dominated Congress and past a states’ rights Supreme Court. But we finally managed to bring about both reforms, and neither one depended on considerations of effectiveness, efficiency or expense.

For many years we were apparently ashamed of what we had done. It was said that slavery had become unprofitable, and that it would have died out anyway, sooner rather than later. It was also argued that most slaves were well cared for because they were worth good money, and that slave labor was really more expensive than free labor. The quasi-Marxian conclusion of these claims was that the true force behind abolition was the profit motive, not the brotherhood of man. No one raised the question of why it was thought necessary to abolish by law, let alone by force of arms, what was economically unprofitable. Perhaps the invisible hand did not quite work the way Adam Smith had said it did.

The child labor problem was not too different. Economists call all labor a “disutility.” Although few defended, say, having half-naked children (and their mothers) scramble on all fours like stunted donkeys to drag carts of coal through constricted mine drifts, market forces did not work against such atrocities because they were cost-effective.

In short, the fundamental economic problems are not solved-do not even exist-on so-called economic grounds. Efficiency and cost-effectiveness are not standards of right conduct. They are not primary rules for the good economy or the good life.

The thing about primary rules of right conduct is that they are not absolute, as 7+5=12 is absolute. They are local, for a time and place. They are historical. For a few obvious examples, we note that only recently has a 35-hour week come to be considered a full-time job. The 40-hour week was a goal 60 years ago, and our forefathers talked of working from sun to sun.

Likewise, what constitutes decent living conditions has changed and continues to change. The first public housing built by the New Deal had to exclude interior plumbing, not because of the cost, but because private housing of the time and place ordinarily lacked it.

Insofar as the length of the workweek and conditions of living are standards, they have nothing to do with either carrots or sticks. It is barbarous to apply the carrot-or-stick metaphor to human beings. Human beings are not a means to an end; we are all ends in ourselves. It is in this basic sense that we are all equal equally absolute and absolutely equal.

Rousseau said the state exists to force men to be free, but such force is vicious if the state does not also guarantee the opportunity to exercise freedom. Workfare as we now know it does not guarantee that opportunity, and so must resort to carrots and sticks to trick or beat donkeys into line.

Workfare will fail to meet the needs of our democratic society until it is guided by these two principles: First, the right of every citizen to make a contribution to the common weal-that is, to have a decent job-is equal to the state’s right to hold him or her to obedience to its laws.

Second, any full-time job that does not provide a decent and honorable living is not worth being done except as a favor or a hobby, as training or as punishment, or in defense of the realm.

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I DON’T want to alarm anyone, but I think it important for us to realize that the United States of America is about to sail into unfamiliar waters. What is more, those waters are inaccurately charted.

Many years ago I had occasion to consult charts of the Aegean Sea, the island pocked body of water between Greece and Asia Minor. From 1522 to 1912 the principal southern islands were occupied by the Ottoman Turks, and from 1912 to 1947 by Italy. I used British revisions of charts originally prepared by the Italian Navy. Scores of tiny islands and mid sea rock formations had notations beside them: “Reported 2.6 mi. north, 1949,” or “Reported 1.9 mi. south, 1948.”

The economic waters we are now entering are at least as badly charted. The years 1947, 1948, 1949, 1951, 1956, 1957, 1960, and 1969 are the only ones since the great Crash of 1929 in which we managed to balance the Federal budget. As we shall see, what happened in those eight years is the diametrical opposite of what is generally assumed, and our misconception is driving us in an unexpected and unhappy direction.

We need to understand this because we are approaching another balanced budget much faster than anyone thought possible. Indeed, the embarrassing fact is that tax revenues are so good in today’s relatively affluent society that the budget would balance itself in a couple of years if Congress just sat on its hands and watched[1].

The universal mantra has been that we must at any cost balance the budget by 2002. We came within two votes of .launching a Constitutional amendment to that effect. I suppose most people have forgotten the reasoning behind the mantra. Forgetfulness, of course, is what mantras, like the Big Lie, are for. No matter.

The various reasons that were given for balancing the budget a couple of years ago appear to have been reduced to one: President Clinton, House Speaker Newt Gingrich and all their economic advisers say that the balancing will lower the interest rate and hence save good citizens money as well as make for prosperity.

Yes, but I seem to remember that six months ago-on March 25, 1997, to be precise-the Federal Reserve Board kicked the Federal funds rate up a quarter of a point, and soon thereafter every other interest rate went up at least that much. What was the budget news then? There was certainly a noisy squabble going on, but was there anyone, inside the Beltway or out, who was proposing to increase the deficit? If no one was even thinking about such a thing, why did the interest rate go up?

We don’t have to reach back as far as March 25 for incongruities. In the midst of the budgeteers’ recent self-congratulations, the Bureau of Labor Statistics of the Department of Labor announced that the official unemployment rate had fallen to 4.8 per cent (it’s since crept up a tenth of a point or two). That prompted a flood of professional prophecies that the Federal Reserve Board would have to (the Board seems never to act of its own free will) raise the interest rate again to keep more people from getting jobs.

And shortly thereafter the International Monetary Fund, well-known for its conventional views, cautioned that “undue delay in tightening monetary policy could undermine the current expansion.”

Look at the crosscurrents we have drifted into:

News about an imminent budget balance, which is supposed to presage prosperity.

News about falling unemployment, which you might think would be an essential element of prosperit

Prophecies about necessarily rising interest rates, which must be bad if it’s good to balance the budget to get lower rates.

I always look forward to the televised versions of these reports, because they often include questions by Congressmen and answers by the Chairman. The Times and the Wall Street Journal usually provide little more than a summary of the Chairman’s prepared remarks. Constant readers may remember my excitement two years ago (“What Greenspan Really Told Congress,” NL, July 17-31, 1995), when I scooped the world with the news that Greenspan doesn’t believe in NAIRU (or a natural rate of unemployment), that he doesn’t think we must have high interest rates in order to sell our bonds, and that he does think the increasing inequality of incomes is the most serious economic problem now facing the United States.

No doubt chagrined by my scooping them, the rest of the media have not noticed my reportage (though I have a videotape of Greenspan’s words). Neither were they moved to fully report Greenspan’s latest testimony, although in the course of it he had a wary yet respectful exchange with Congressman Jesse L. Jackson Jr. of Illinois.

Jackson questioned the wisdom of relying on the official unemployment figures, since they count as unemployed only people who looked for work last week. A better number, Jackson suggested, would include those too discouraged to continue looking for work, those too turned off ever to have looked for lawful work, those working part time when they would rather work full time, and those slogging away at jobs for which they are overqualified. If all these people were counted, Jackson said, unemployment would be nearer 20 million than the officially reported 6 million or 7 million.

Greenspan replied that he did not know enough about the people Jackson mentioned to use them as a basis for policy, but he acknowledged that they exist. His acknowledgment is my scoop for this week. For I submit that an economy incapable of providing proper jobs for 15 or 20 per cent of its work force is not an adequate economy. It may be “prosperous,” but it does not come close to doing what an economy ought to do. So we have a fourth crosscurrent to reckon with as we approach the waters whose charts are questionable.

PRESIDENT CLINTON and Speaker Gingrich and practically the entire economics profession, as I have said, are united in steering us toward a balanced budget on the theory that this will reward us with lower interest rates. A look at the records, however, reveals that in every one of the eight post-Depression years with a balanced Federal budget the prime interest rate (to which most rates we pay are related) went up, not down. We must conclude, therefore, that either our leaders or the records (or both) have lost their bearings. Clinton, for instance, claims credit for reducing the Federal deficit and says it has resulted in lower interest rates. Granted, recent budgets have boasted a reduced deficit. The Republicans, not surprisingly, insist they brought about the reductions, but that’s not what is plainly wrong with the President’s story.

What’s wrong is that although the deficit has gone down in all five years of his watch, the interest rate went up in three of them -1994, 1995 and 1997-and the prime rate is now two full points higher than it was when Clinton took office.

In other words, five years of reinventing government-of “it’s the economy, stupid”; of the end of welfare as we know it; of the end of the era of big government-have brought forth, not a decrease, but an increase of 32 per cent in the prime interest rate. The emperor, his advisers and his loyal opposition may have plenty of new clothes; they just have them on inside out and backward. There is no empirical evidence whatever that a falling deficit causes or inspires or favors or even accompanies lower interest rates.

Nor is there evidence for a contrary causation: A high deficit has not automatically produced high interest rates. Consider the famous years 1981 through 1986, when Ronald Reagan was President and Paul A. Volcker was the Federal Reserve Board Chairman. The prime interest rate fell from 21.5 per cent to 7.5 per cent. Was this the result of a falling budget deficit? Hardly. The deficit more than tripled in those years, and the interest rate went down at an equally record breaking pace.

Conventional economics, incidentally, teaches that high deficits cause high inflation, and that high interest rates cure inflation. Consequently, true believers should expect that inflation soared in the Reagan- Volcker years. Again the records belie conventional expectations. In 1981 the annual change in the Consumer Price Index was 10.3 per cent. In 1986 it was only 1.9 per cent.

In short, the economic waters we are now entering are charted to correlate high deficits with high interest rates and low inflation. A realistic mapping, though, shows that low or nonexistent deficits are not associated with falling interest rates, while high interest rates are commonly associated with high inflation.

The discrepancies between the conventional view of the economy and its recent performance lead me to suggest the future may prove Proust was right in observing that our desires may be fulfilled on condition that they do not bring the happiness we expect of them. We may succeed in balancing the budget, but it is exceedingly unlikely that the interest rate will fall as far as our leaders and advisers expect. Even if the rate should drop a point or two, it is unlikely that business will correspondingly expand. If anything, a balanced budget will act as a constraint on business, in the same way that the drive for a balanced budget has constrained expenditures for maintaining our infrastructure, for improving the lot of the disadvantaged among us, and for nurturing progress in the arts and sciences.

Is there no limit to the deficit that we can sustain? Sure there is a limit. My father advised my wife and me always to stretch a little when buying a home for our family. That way we could, and did, steadily improve our standard of living. Naturally, we had to be able to pay the interest on our successive mortgages. It is the same with a capitalist nation. Capitalism is based on borrowing as much as it can from the future in order to build for the future.

A zero deficit is a confession of a failure of faith in the future, especially when 20 million citizens lack proper jobs.

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I SUBMIT that it’s time to give it up, quit, call a halt, put an end to the nonsense and the grief it has caused. The charade has had a run of almost 30 years. That is surely long enough for any group of people to toy with the wealth, health and happiness of their fellows.

Friedman himself based the theory on mumbo-jumbo about nominal wages and real wages that would make inflation rise à outrance if unemployment fell below the natural rate. Some stirred that up with the productivity scam; a standard reference book disregarded the foregoing ploys but introduced three others; and an international conference was devoted to the imagined connection between NAIRU and hysteresis, a phenomenon characteristic of ferrous metals in an electromagnetic field. (No, no, I did not make that up.)

As the natural rate theories began to unfold, their beauty, not to say elegance, began to be appreciated. For, look you: If there is a natural rate of unemployment, the most difficult and most important questions of economics-those that have to do with people-are answered. Better, they’re made to disappear; there’s no point in asking them.

To struggling scholars, the theory of a natural rate of unemployment has been a godsend. The frosting on the cake is Professor Friedman’s dictum that, for certain technical reasons, “the monetary authority [aka the Federal Reserve Board] cannot know what the ‘natural’ rate is.” This being accepted, tenure-track economists can consolidate their careers by writing learned articles conclusively demonstrating whatever rate tickles their fancy, and no one can say them nay.

Well, that’s not quite right. Reasoning from the pronouncements of professional economists, we conclude that, whatever the actual rate of unemployment, the natural rate must always be higher, because the actual rate is always low enough to convince pundits that a lot of people must be fired at once to prevent runaway inflation, or to allow us to compete in the new global economy, or to keep the Federal Reserve from raising the interest rate and disquieting the stock market.

In the new welfare-as-we-never-knew-it-world, we are beginning to push people off welfare and onto workfare, and we are beginning to see the absurdities and the nastiness of the schemes. In New York an attempt is being made to unionize the new workers. The local authorities are resisting on the ground that the new workers are not really workers at all, because they don’t work full time, and they don’t have vacations, and they don’t have proper tools and equipment, and they aren’t paid a living wage.

I expect that the Bureau of Labor Statistics will go along and not count them, just as it didn’t count as employed the millions who worked for the CCC and WPA and the rest of the “alphabet soup” programs of New Deal days. (How else do you think unemployment hit 17.2 percent in 1939, as the books say it did, under that Old Democrat FDR?) These people were paid for what they did, and much of it survives for our pleasure and enlightenment to this day, but they didn’t get counted.

Think what would happen to the natural rate of unemployment if the millions of victims of workfare were counted as really-truly workers. Once the states got the new system in full swing, unemployment would theoretically be cut at least in half-say, to 2 or 2.5 per cent. Inflation would of course go straight up; its curve would be vertical; and the interest rate would have to follow in hot pursuit.

Think of it.

I, too, think that is absurd. But I ask you: Why is it absurd? Don’t tell me that most workfare workers aren’t eager to work. The same can be said for more than a few in the private sector, even at fairly exalted levels-which may explain why golf courses and ski runs are busy seven days a week, in season. After all, the “classics” held that work is a “disutility” that is overcome only when workers are tempted with high wages.

The absurdity is not in the people, whether employed or unemployed. The absurdity is in the theory of a natural rate of unemployment. The theory is fallacious as well as vicious. The fallacy appears at the very beginning, where it is assumed that inflation is caused on the supply side by the cost of labor and on the demand side by the purchases of laborers.

Labor costs are indeed the largest category of expenses, but they are only about 60 per cent of the Gross Domestic Product (GDP). The other 40 per cent includes rent, interest, insurance, taxes, and profits, which obviously don’t all move at the same slow pace as wages, or even in the same direction. Labor costs, moreover, are not homogeneous, but can be usefully divided into three categories with pretty distinctive behavior: the takings of the working rich (say, those with annual incomes in excess of $175,000); the wages of the working poor (those mired below the poverty level); and the salaries of the working middle class.

So we have eight factor costs that affect the supply side of the price level, instead of the single omnibus wage cost of the NAIRU theory. Of the eight, four have certainly soared during the past couple of decades: interest, insurance, profits, and the takings of the working rich (entertainers’ professional athletes, business executives, and other celebrities). The salaries of the middle class, though, have stagnated, while the wages of the working poor have grievously fallen[1].

Now, when the unemployment rate falls a tenth of a point because several hundred thousand people get jobs, who are the new workers? Well, a handful may be newly minted celebrities or previously downsized executives, but most of the rest meld into the bottom half of the working middle class or the working poor-categories that have not been responsible for inflation’s costs.

Nor will the lower categories be responsible for any substantial increase on the demand side. These people, even when unemployed, already did a bit of demanding or consuming. They weren’t quite starving or freezing to death. The welfare reformers, in fact, thought they had it too good. Since most of the new workers will be paid close to the minimum wage (which is below the poverty level), they will not be able to demand much more in the way of goods and services than they did when unemployed. That is not the way things ought to be, but it shamefully is the way they are and will be for the foreseeable future.

When unemployment falls, the new members of the working poor will not make a crucial difference to either the supply side or the demand side. Their effect on the price level will be negligible. They will, however, make a salutary contribution to the GDP, cause a great fall in welfare expenses, and add nicely to Federal and state and local tax receipts.

IT IS IN EVERYWAY, at all levels, a good thing for unemployment to fall-and in a rational economy that would be a principal objective of public policy. Yet in the world of conventional economics, this happy event is irrationally supposed by NAIRU theorists to be the harbinger of inflation to come. It sets off a great hue and cry in the universities and on Wall Street, explaining why the Federal Reserve Board will have to–will be required by economic law to[2]-raise the interest rate high enough to induce recession.

As an example of the wild claims made by conventional economists, we may consider a 1990 proclamation by Professor Paul Krugman of MIT that if we tried to increase employment by 2 million people, “inflation would begin to accelerate rapidly.” In the event, employment was essentially unchanged for two years, and the Consumer Price Index (CPI) fell from 5.4 per cent to 3.0 per cent. Since 1992, employment has increased by over 4 million a year, and the CPI has, yes, fallen to 1.4 per cent. If we use the figures of the Boskin Commission that economists were praising last winter, inflation now is only 0.3 per cent-repeat, three-tenths of one per cent-a year.

In its perennial struggle with the inflation banshee, the Federal Reserve has sponsored eight recessions since World War II. Not only were trillions of dollars’ worth of commodities never produced (it can be argued that we have too much stuff anyway), but millions of our fellow men and women were forced into poverty, their hopes for a better life dashed.

That is a monstrous shame we all bear, a shame brought about by arrogance in league with ignorance. After 30 years, the ignorance is no longer excusable-if it ever was. We are at present in an economy whose unemployment rate is falling -even without counting our workfare fellows as employed-and whose inflation rate is approaching zero. And we have seen unemployment fall despite the conventionally feared minimum wage law, specifically mentioned by Professor Friedman as increasing the natural rate of unemployment.

Federal Reserve Chairman Alan Greenspan, we have noted hopefully here more than once, claims not to be a believer in NAIRU. Nevertheless, in his recent semiannual testimony before Congress he felt obligated to warn that if things don’t slow down, the Reserve will raise the interest rate. Should he carry out his threat, he will hurt the poor and especially the lower middle class, who, as we have seen, are not responsible for inflation, and he will benefit the rich, who are to blame. This is not statesmanship; it is madness.

Perhaps the Chairman still fears an over exuberant stock market. That may be sensible, but raising the interest rate will attempt to exorcise the fear by taking billions of dollars from the borrowers among us and giving them to the lenders. The attempt will succeed only if he manages to bring on another recession. This, too, is madness, not statesmanship.

It is also NAIRU by another name. The natural rate of unemployment, the nonaccelerating inflation rate of unemployment, NAIRU-the whole mess-is fallacious in theory, erroneous in fact, and immoral in consequence. Let there be an end to it.

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WELL, IT LOOKS as though Europe’s central bankers have blown it. The rest of us may rejoice. The Socialist victory means that France will no longer try to destroy its economy in order to qualify for admission to the European System of Central Banks, which is supposed to administer the new currency called the euro. And Chancellor Helmut Kohl‘s squabble with the Bundesbank over the valuation of his country’s gold reserve will probably disqualify Germany.

The principal tests each European nation must pass in order to be admitted to the System of Central Banks are that its deficit cannot be more than 3 per cent of its GDP, and its debt cannot be more than

60 per cent of its GDP. The only country now certain to meet the standards is the Grand Duchy of Luxembourg, whose population is 415,870, and whose territory is about 32 miles square.

The announced intention of the deficit and debt tests was to get the national currencies in line so that they could be exchanged, mark for euro, franc for euro, lira for euro, and so on until the local currencies all disappeared in June 2002 (the same magical year that is supposed make our minimal deficit disappear).

I must confess that I don’t ordinarily think like a banker; so the scheme doesn’t much appeal to me. I can understand why the usually strident enthusiasts for a free market have, in this instance, fallen silent. There are several active markets where thousands of shirt-sleeved, hardworking people make money the old fashioned way: They speculate in it. The results of their speculations are regularly published in the financial press, and may (or may not) be used by the friendly concierge at your friendly Paris hotel to decide how many francs and centimes he’ll give you for your American Express Travelers’ checks. These listings, although arrived at with the most invigorating absence of regulation, often have currencies making daily jumps of five or more points against one another, and are far too volatile to be used to establish the value of the euro or anything else.

The problem of a fair exchange among currencies is, however, precisely the sort of problem that the Consumer Price Index was designed to solve. As I’ve said here more than once, the CPI doesn’t really tell us much about the cost of living and never was intended to do so. It does tell how many units of a given currency it takes to buy some selected basket of stuff.

The CPl’s figures report each month the cost in American dollars of an American basketful. The European basket would, of course, be different, but it would be the same all over Europe. During an agreed-on day or week, researchers would fan out over each of the candidate countries with identical baskets. In France they’d calculate how many francs the basket would cost; in Italy how many lira; in Sweden how many ore; in Germany how many marks, und so weiter. It would then be a simple matter to determine how many units of each currency are equal to a Luxembourgeois franc (choosing that standard so the bigger countries wouldn’t be jealous of each other), whereupon the euro could be declared equal to some multiple of the Luxembourgeois franc.

With a soothing whirr of calculators, the job would be done. Everyone would exchange marks and francs and pounds sterling for euros at the appropriate rates, and any bits of the old currencies that were not exchanged would become collectors’ items, like Confederate dollars. Why has Europe instead undertaken a complicated procedure that has caused widespread political uneasiness and distress?

Well, the central bankers were in charge, and the central bankers (unlike the friendly people you deal with) thought they had a chance to force all Europe into compliance with their peculiar notions of how the world should work. The unhappy probability is that most of the citizens of the European nations, like most of the citizens of the United States of America, are too lazy or too befuddled to think for more than a news byte about what is at stake. Willie Sutton was interested in banks because that’s where the money is, and we are in awe of bankers because they’re the people who are where the money is.

The Maastricht Treaty‘s insistence on debt and deficit standards is an indication that more than currency unification was being provided for. As we have seen, currencies can readily be unified without all the mumbo-jumbo. Everyone knows that the mark is stronger than the lira. (At the inauspicious start of a spring day in 1973, President R. M. Nixon said to his chief of staff H. R. Haldeman, “Expletive the lira.”) Once the relative strengths had been established, and both mark and lira had disappeared into the euro, it would no longer matter whether or why one used to be weaker than the other.

If the difference was caused by Italian over-exuberance, as it may have been, Italy can continue to finance such policies by selling bonds denominated in euros and paying interest in euros, just as New York

City sells bonds denominated in dollars and pays interest in dollars. Italy’s post-unification bonds will no doubt be harder to sell than Germany’s, where politics tends to be more dour, and will have to pay a higher interest rate, though both are denominated in euros, just as New York City’s bonds pay a far higher interest rate than Westchester County‘s, though both are denominated in dollars.

The soundness of the dollar does not depend on the soundness of New York City’s financing, and the soundness of the euro will depend not on the debts or deficits of the member states, but on whether the euro is accepted as the only legal tender by unavoidable taxing authorities. The history of the United States is instructive on this point[1].

The Continental Congress financed the Revolution by paying its soldiers and suppliers with IOUs called Continentals (today we call our IOUs Federal Reserve notes or Treasury bonds and notes). But the Continental Congress had no power to tax; it could only ask the 13 colonies for funds, and the same was true of the government later formed under the Articles of Confederation. Even during the war, “sunshine patriots” of the sort castigated by Tom Paine refused to accept Continentals, and after the War the expression “Not worth a Continental” entered the lexicon. In 1790 Alexander Hamilton persuaded the new Constitutional Congress, which had the power to tax, to assume the war debts, which is another story, a proud (but not altogether happy) one.

In the Europe of the Maastricht Treaty, the low deficit standard for entry into membership would be required for continuing membership, presumably to keep the euro sound. There is, however, neither rational argument nor empirical evidence linking a low deficit with sound money.

The sound money theory is based on the naive and archaic notion that there is a determinate quantity of lendable money, and that a big deficit soaks up part of that money, leaving less for private business. But money is credit, and credit expands as creditable business expands. Financing the explosive growth of the computer industry has not dried up funds for government bonds or home mortgages or any other purpose. Rather the contrary.

In the United States, the conventional mantra is that we must balance the budget in order to get lower interest rates, and we are ripping jagged holes in our social and cultural fabric to that end. Yet in the half century since the Good War, the interest rate went up, not down, in every one of the eight years in which we managed to balance the budget; and deficits and interest rates have gone up or down together only 15 times out of 50.

Nor is there a correlation between deficit and inflation. In every Reagan year the deficit was greater (generally far greater) than in any Carter year; yet in every Reagan year except one the annual change in the CPI was less than in any Carter year.

THE CAPITALIST system as it has developed in the past 150 years is distinguished from all previous systems by the extent and fluidity of borrowing. “Neither a borrower nor a lender be” was the advice of a Renaissance courtier, and not a remarkably successful one. Everyone is excited by the current stock market boom, but even at its present questionable valuation, there is in the stock market less than half as much money as is invested in the personal, corporate and public debt of the nonfinancial sectors of the economy.

Given the tremendous growth of modern capitalism, which (to repeat) is based on borrowing, and given the empirical record that we have sampled, it is difficult to imagine why central bankers (and conventional economists) persist in considering public debt something naughty that must be suppressed. Yet the United States seems determined to regress to a fundamentally mercantilist society by 2002, and Europe has an even more restrictive aim.

If the objective were merely slowing or rationalizing the consumption of the Earth’s natural resources, a case could be made. Nothing so sensible as that is in mind. Instead, roughly the bottom half of society is earmarked to pay the costs of this peculiar unification. All over Europe unemployment is at record heights, and all over Europe nations are scrabbling (as we are scrabbling) to reduce job protection, medical insurance, unemployment benefits, welfare rights, the social safety net, and all sorts of social and cultural amenities.

Europe is in a worse mess than the United States because for 15 years European interest rates have been higher than ours, and European tax systems (heavily dependent on payroll taxes and the value added tax and, incidentally, without a capital gains tax) are less rational than ours. Europe is in more danger from austerity programs than the United States because the new European Central Bank will be more independent and even more arrogant than the Federal Reserve Board.

According to the Maastricht Treaty, “The Community institutions and bodies and the governments of the Member States undertake not to seek to influence the members of the decision-making bodies of the ECB or of the national central banks in the performance of their tasks.”

Put that cozy provision alongside the recent announcement of the Bundesbank (the role model for the European system central banks) that they will not consider Germany’s 11.3 per cent unemployment rate when they establish monetary policy, and you have to hope that the treaty will be thoroughly revised.

No nation, no community of nations, no world of nations can strengthen its economy by keeping people from working. Downsizing and austerity may work for a few self-centered corporations; it is counterproductive for a nation or a community or the world as a whole.

So far it would seem that the principal European leader to understand this simple truth is Michael Dietzsch, head of the German brewers, who recently observed that the sluggishness in his industry is caused by the fact that 4.5 million German beer drinkers are out of work. Would that there were more leaders-including a few American leaders-as clearheaded as he.

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IN CONGRESSIONAL testimony, Chairman Alan P. Greenspan of the Federal Reserve Boardhas talked, in his gnomic way, about the rich getting richer and the poor getting poorer. Responding to a Congressman’s question, he testified: “There has been a regrettable dispersion of incomes that goes back to the later ’60s …. What’s the major threat to our society? I’d list this as a crucial issue. If it divides the society, I do not think that is good for any democracy of which I am aware.”

Sometimes you want to shake the man. He has done a bit to open up the Federal Reserve Board to public scrutiny, but often it seems he can’t make a straightforward declarative statement. There is no “if” about this proposition. Of course the “dispersion of incomes” divides the society. It does so by definition. We’ve known that since Aristotle. Whether or not there may be some democracies of which he is not aware, the dispersion is certainly not good for a democracy that was conceived in liberty and dedicated to the proposition that all men are created equal.

Later in his testimony Mr. Greenspan expressed regret that the Federal Reserve Board lacked the power to contribute to the solution of the problem. Whether it truly lacks that power is surely debatable.

What is beyond debate is that the Federal Reserve Board can make the problem worse. For they in fact did so as recently as March 25, 1997.

By raising the interest rate, the Reserve slowed the economy down-deliberately. A slowdown means that fewer goods and services will be sold than would have been sold otherwise-not necessarily fewer than are sold today, but certainly fewer than might have been sold tomorrow.

Since fewer goods and services will be sold, fewer will be supplied, and fewer people will be employed in supplying them. Since fewer people will be employed, fewer people will have money with which to “demand” goods and services. And since fewer people will be employed, those lucky enough to have jobs will hesitate to ask for raises and so also will have less money with which to demand goods and services. The expectation is that inflation will be contained or pre-emptively struck, depending on the metaphor you’re using this week, and that the rest of us will be free to choose among moderately priced commodities.

Now, it is obvious to everyone except (perhaps) the Federal Reserve Board that if raising the interest rate does in fact contain or pre-empt inflation, it does so at the expense of the workers and the would be workers of America. In other words, most of the poor will be poorer.

And will anyone be richer? That, too, should be obvious. When the interest rate is raised, someone benefits. Who else can that be but people with money to lend, that is, people with more money than they need for daily expenses of living? We may call these people rich. And most of them will be richer.

Nor will the middle class escape unscathed. For convenience, let’s say the middle class consists of all people who are constantly making mortgage payments or payments on their automobile or payments on educational loans or payments on their furniture or on their credit cards. They’re like the government: They pay their bills, and their credit is good, but they don’t balance their budgets.

These people will be hurt, some more than others, by the increase in interest rates, and the rich will be made richer at their expense. Since March 25, 1997, everyone with an outstanding variable rate loan and anyone taking out a new loan to buy a house, a car, a refrigerator, a loveseat, or a college education has been paying more-in some cases thousands of dollars more-than would have been required before March 25. Anyone lending after that date is correspondingly enriched. (Yes, most of the lending is done by banks and such, but these institutions are owned by people who are not poor.)

The rich will be distanced farther from everyone, from the middle class as well as from the poor. The rich have done nothing to deserve their increased incomes. They have not denied themselves more pleasures to finance the activities of the rest of us, and they will not be required, or even requested, to do anything. Their increased interest income is an outright gift from their fellow citizens, from the nation’s businesses, and from the Federal, state and local governments and school districts.

Nor has the middle class done anything to deserve having part of their wealth and income taken away from them. However large or small the part may be, it is, as the politicians say, their money-and it’s being given, not to the government for the presumed good of all, nor to some charity of their choice, but to the rich merely because they are rich.

As for the poor, they have done nothing to deserve the refusal of raises they might have had, or the denial of jobs that might have been created, or the downsizing from jobs they once had. Bernard Shaw’s Undeserving Poor are surely still with us, and some of them are doubtless unemployable, but the malign consequences- the intended malign consequences- of the increase in the interest rate will be visited on the poor whether they are otherwise deserving or not.

Some say that a quarter-point increase in the interest rate can’t hurt anyone very much. If that is so, why do it? The intention is to hurt. The alleged need is to hurt enough to force people to buy less, to consume less, to enjoy less.

Anyhow, the question before us is not whether it hurts, but whether it increases what Mr. Greenspan calls the dispersion of incomes. The answer to that question is clear. Because of the quarter-point increase in the interest rate, the total annual incomes of the richest 5 per cent of the population will be increased by several billion dollars, and the total annual incomes of the other 95 per cent will be decreased by several billion dollars. Moreover, since the rich are so few, they will, on average, grow richer almost 20 times as fast as their average fellow citizen becomes poorer. The income gap will continue to widen as long as the new rate is in effect, and it will widen even further if, as expected, the Reserve increases the rate again and again during the coming months.

The Federal Reserve Board has singlehandedly effected all these increased dispersions in income. Why did they do it? Surely they are not altogether oblivious of what happens to real people and real societies in the real world.

Well, we know why they did it. They’ve told us plenty of times. They were fighting inflation. They were fighting inflation when they caused recessions in 1954, 1958, 1961, 1970, 1975, 1980, 1982, and 1991. They’ve been fighting inflation, although they now say inflation never was as high as reported. They’ve been fighting inflation, although they’ve never made clear exactly what inflation is.

EVIDENTLY inflation is not all prices going up together, because they never have all gone up together; and since ordinary business requires making contracts at fixed prices, they never could all go up together. Evidently inflation is not an increase in the price of energy (a.k.a. oil) or an increase in the price of food, because economists have now concluded that these prices are controlled by foreigners or the weather or both. Evidently inflation is not an increase in the multimillion-dollar salaries of executives, entertainers and professional athletes, because such incentives are said to be needed to bring out the best in lethargic souls.

Evidently inflation is not an increase in profits, because profits are what it’s all about. Evidently inflation is not an increase in the cost of borrowing money, because raising the interest rate is the sole weapon the central bank uses in its perennial fight against inflation.

So what is left? Judging from press reports, it would appear that the chief signs of inflation are a fall in the unemployment rate, a fall in the number of new applications for unemployment insurance benefits, faint signs that some wages may be rising almost as fast as productivity, and improvement in the sales of discount stores.

As Pogo might have said, conventional economics has met the enemy and they is us. Inflation is some prices going up faster than others. In the conventional lexicon, the only really bad prices are the incomes of the middle class and the poor.

There is little doubt that an increase in these prices would eventually result in increases in some manufactured products, in some of what used to be called dry goods, and in some services. After all, the middle class and the poor do most of the work of the world, and wages are certainly a cost of doing business and thus a factor in prices.

But interest is also a cost of doing business and a factor in prices. Increases in the interest rate thus push up prices. If Mr. Greenspan only grappled on to that simple and obvious fact, and if he took seriously his concerns about a divided society, he might launch a policy of slowly reducing the interest rate, striving to use his great power to achieve a new soft landing for all of us in a larger, more generous, more inclusive, more united, and more rewarding economy.

Conventional economists would of course scream that high interest rates are necessary to enforce a “natural rate of unemployment,” and that the Treasury couldn’t sell its bonds if the rate were reduced to what was common only 40 or 50 years ago (before the dispersion of incomes began). But everyone who is active in the economy wants lower interest rates-the automobile business and its ancillaries, the building industry and its suppliers from producers of carpet tacks to manufacturers of major appliances, all sorts of retail concerns and their customers, managers of mutual funds and their investors, most bankers, and governmental entities at all levels as they struggle to balance their budgets.

Did I say “most bankers”? Of course I did. The usurious rates of the ’70s and ’80s taught them a lesson. To attract and hold deposits they had to compete with Treasury bills paying as much as 16.3 per cent, while the Federal Reserve set a rate of up to 19.1 per cent on interbank loans. Borrowers resisted the rates that banks had to charge and cut their borrowing to the bone. Hundreds of S&Ls were wiped out (see “Who Killed the Savings and Loans?” NL, September 3, 1990), and many regular banks failed.

Mr. Greenspan himself, in answer to a question once posed about the natural rate of unemployment, said, “I don’t believe that any particular unemployment rate-that 5 per cent or 5.5 per cent or whatever numbers we’re dealing with is something desirable in and of itself. I don’t believe that.” Responding to a suggestion that interest rates had to be high to attract foreign bond buyers, he has also said, “I’m not aware that we’ve had very many difficulties selling the debt-the Federal debt at low interest rates.”

Conventional economists may sneer at Mr. Greenspan for voicing such unconventional ideas. A more valid complaint is that he doesn’t act on them.

The New Leader

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THE RECENT four-cents-a-pack boost in the wholesale price of RJR Nabisco‘s line of cigarettes, the reactions of economists thereto, and the presumptive reactions of the other tobacco companies, may serve as a casebook lesson in how today’s economists profess that the economy works, how it actually works, and what the discrepancy portends.

To begin with, there’s no suggestion on anyone’s part that the sacred law of supply and demand had anything remotely to do with the RJR Nabisco price increase. The company was not enticed into raising the price because of a shortage, anywhere in the world, of its current or prospective supply of tobacco. Nor are the company’s competitors lacking in stuff to sell. There are and will be cigarettes to bum.

At the same time, there is no sign of a substantial increase in demand. Regardless of what one may think of President Clinton’s war on teenage smoking (I certainly see no objection to it), the demographics, at least in the United States, point toward a decrease in demand for cigarettes, pipe and chewing tobacco, snuff, and even-despite extraordinary hoopla -cigars. Kids today don’t know enough about tobacco to appreciate the earthshaking humor of asking a tobacconist whether he has Prince Albert in a can. (On receiving an affirmative answer, we broke down in uncontrollable giggles and shrieked, “Well, let him out!”)

The tremendous fuss being made over Social Security should have drummed into everybody’s consciousness the fact that the present younger generation is noticeably smaller than its parents’ baby boomer generation. Whether or not this demographic imbalance is sufficient to put Social Security at risk of insolvency and thus to ignite an intergenerational war, it is not likely to presage a rise in the number of cigarette smokers.

Then there’s the question of market discipline. We were brought up to believe that a shrinking market leads competing producers to lower prices in order to maintain or improve market share. But here we have the precise contrary: Competing producers are expected to raise prices in a shrinking market. You’d think that competitors would be dancing in the streets, advertising their lower prices, and preparing to cut deeply into RJR Nabisco’s market share.

Instead, the New York Times reports economists saying that an increase of almost 5 per cent “is a big number for any consumer products company,” and that “it would be highly unusual for the other tobacco products companies not to follow suit.” What we’re witnessing, in other words, is both the flouting of the law of supply and demand and the failure of the theory of free competition.

Since the economists commenting on the tobacco price hike have not attributed it to the law of supply and demand or to the market discipline of the competitive system, what do they think is going on here? The favored explanation seems to be that the tobacco companies, presumably consulting more than tobacco leaves, believe that a general settlement might be possible in the many and various lawsuits now-facing them, not to mention those still to come. How such a settlement is possible, I am not devious enough to imagine; but I am sufficiently experienced in the ways of the world to fancy that whatever is agreed to will be less costly to the companies than allowing the cases to go to trials, jury verdicts and ultimately to appeals.

Now, if the tobacco companies expect that their expenses will be reduced, why should that be thought an occasion for raising prices? The Wall Street gossip seems to be that the settlement will cost the companies $6 billion, in which case the cost of going to trial is estimated to be rather more than $6 billion, in which case the settlement would represent a handsome improvement in the companies’ prospects. Such an improvement may well justify Wall Street’s reactions to the rumored settlement (stocks of the four leading tobacco companies rose modestly; shares of the fifth largest company, which had previously begun negotiating a settlement, fell). But an improvement in prospects is, according to conventional theory, an occasion for holding prices steady, if not lowering them.

So we find in this episode another example of the failure of the standard theory of free enterprise as it is taught almost universally in American colleges; as it is extolled almost universally in American legislatures, boardrooms and newsrooms; and as it is regularly adjudicated by Federal, state and local courts.

It is, of course, clear enough why the standard theory is failing in this instance. There may be competition of sorts among the leading brands, but it is mostly shadow-boxing between their advertising agencies. The companies are too few and too big for serious warfare. None of them would gain much by competing so vigorously that one or even all of the others was forced out of business, and the attempt would be very costly.

For one thing, each company can count on a certain amount of brand loyalty. In the bad old days, for example, I, as an upwardly mobile young man of educated and refined taste, resolutely smoked Chesterfields because their packs were the easiest to open. More important, smokers, once hooked, don’t have much choice. At the same time that someone is boycotting RJR Nabisco for raising prices, somebody is boycotting Brown & Williamson for something their president said (or, perhaps, refused to say) to Mike Wallace of 60 Minutes, somebody else is boycotting Philip Morris for sponsoring an exhibit of an unfavored artist, and so on.

So long as the boycotters keep smoking, it’s a game of musical chairs in which the music never stops. As some philosopher said, you win some, and you lose some.

ON REFLECTION, it’s the same with big-ticket items as it is with cigarettes. We used to have two cars. Our first fleet, as we called it, was of Chevys. It happened, when it came time to get new ones, that I was mad at General Motors for some reason I’ve forgotten; so we cased the Ford showrooms, finally coming to an agreement on a station wagon and a convertible (we were still upwardly mobile). The wagon, which my wife drove, reached the 1,000-mile mark first, and one evening she drove it over to the dealer, me following in the convertible, for its scheduled tune-up.

The dealer said it would be ready in three days, and when my wife objected at so much time for so minor a job, he explained that they were very busy. Three days later we went back, but it wasn’t ready. Sorry: we should call beforehand the next time. I suggested that he call us when it was ready, but he protested that he didn’t have the time. I drew myself up to my full height and proclaimed that if he didn’t call, we’d never buy a car from him again.

Our next fleet, as I imagine he expected (if he gave a damn), was of Plymouths, and somebody was probably deserting Plymouth for Ford for some reason as weighty as mine. You win some, and you lose some.

And that’s the way competition and market discipline and all that stuff really works, with big tickets as well as small. I’m not claiming that all automobile dealers are surly fools, or even that all cigarette manufacturers are indifferent to the hopes and fears of the public. It is altogether possible that many, or even most, producers modify their products when they are convinced they are losing business to competitors.

Such modifications, however, are not necessarily for the better. When concerned citizens complain about the trash available in movie theaters and on television and at supermarket checkout counters, the bland reply is that the public gets what it wants. Are the editors of THE NEW LEADER to be criticized for stubbornly printing this sort of column instead of running something more appealing in the centerfold?

When push comes to shove, it’s pretty clear that we really do not believe in market discipline, whatever that may be, and however much we may prattle on about it. We do not believe that the sellingest bestseller is ipso facto the best book, nor that the most widely boomed music is the best music, nor that the most colorful sunset is the best painting. We do not believe that the Wright brothers were fools for sticking with their idea even though it seemed there would never be any money in it. We do not believe that Mahatma Gandhi‘s life was a failure because he died broke.

Our theory and our practice are obviously in conflict with each other. This is, to be sure, not the first time in our history that we have faced such a conflict, and it is not the first time that our theoreticians and our practitioners have failed to notice it. That inattention is perhaps the most disturbing aspect of the situation, for it suggests that we do not really believe, possibly do not understand, and evidently do not care about the words with which we so regularly celebrate the virtues of our society.

There is, in short, a hollowness at the core of our society. A hollowness almost destroyed us in 1861, and another nearly did us in 68 years ago just when perpetual prosperity seemed assured. A similar hollowness did in fact destroy the Soviet Union at the height of its power, as the national slogan, “From each according to his abilities, to each according to his needs,” though embodied in the Constitution, became routinely and carelessly honored in the breach.

I am not saying that we are on the brink of disaster. I am saying that the brink is never far away, and that we’d better set about revising our theory or our practice or, if we are up to it, both.

The New Leader

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THE LAST TIME I saw Michael J. Boskin on the tube, he was Chairman of the President’s Council of Economic Advisers under George Bush, and he was arguing against extending jobless insurance as the 1991 recession dragged on. Doing this would, he explained, discourage the unemployed from rushing to grab new jobs-jobs that were, he neglected to point out, a lot worse and paid a lot less than those they’d lost.

Now Boskin is being presented as the fellow with a nonpolitical scientific story about the Consumer Price Index. In 1995 the Senate Finance Committee put him in charge of an independent commission appointed to look at the accuracy of the CPI as a measure of inflation; a few months ago the panel issued its report, and since then he has been very much with us. As I listen to him these days, I am reminded of Carl Jonas‘ comic novel The Sputnik Rapist, in which an old goat of an aging mountain man is sweet talking an Indian maiden, whispering in her ear about the great time they’re having. She replies, “Well, perhaps, but I think I’m being screwed.”

I’ve already given you my notion that the CPI is not, and never was meant to be, a COLA. It measures changes in the price level, and that is not the same as changes in the cost of living (see “What Does It Cost You To Live?” NL, June 3-17, 1996). I don’t propose to go into that again in detail, but I do have a couple of points to add.

Professor Boskin and other members of his commission all have a lot to say about how the CPI doesn’t adequately measure the improvement in products over time. Automobiles last longer than in the past, they point out, so no wonder a car costs more. Well, I don’t know about you, but I run my automobile longer than

I used to because the new ones cost too much. In fact, the last new car I bought was in 1982.

Besides, they contend, items that used to be extras are now standard equipment, and so should be reflected in the CPI; what is more, the equipment is better than it used to be. Perhaps it is, but I used to be able (it was a fight, but I could win it) to buy a car without a radio and a tape deck and CD player and quadrilateral sound and white sidewall tires.

Still, the Boskin commission thinks the CPI should be cut 0.6 percentage points for these reasons.

Another claim they make, exactly contrary to the previous one, is that lots of things-literature, for example-are cheaper than they used to be. Eight or 10 years ago, a best-selling novel was $12.95 in hardcover; now it might be $25, but you can get a paperback for $10.95, and so are better off. (paperbacks once were 25 cents, but let that pass.) Indeed, they say, you don’t have to spend even $10.95, you can go to the library for free.

I seem to remember that we could go to the library for free when we were children and the world was young; so the cost of reading shouldn’t be a factor in the CPI anyhow, even assuming that the CPI measures changes in the cost of living rather than changes in the price level. Speaking of-libraries, however, how do you factor in the fact that increased book and magazine prices, coupled with decreased budgets, have forced reductions in the number of books purchased and also in the hours libraries are open?

Finally, they want to knock off 0.1 of a percentage point for the availability of less expensive places to shop, like warehouses. I don’t know of such a place in my neighborhood; and even if there were one, I can’t imagine how I’d get the stuff home or where I’d store it if I did get it home. I’d have to rent a larger place, which would surely cancel the savings from buying wholesale, not to mention the interest I’d have to pay on my investment in canned goods.

The grand total of all the deductions comes to 1.1 percentage points. While this doesn’t sound like much, it amounts to between three-tenths and a half of recent COLAS. Everything I’ve said, of course, is anecdotal, but so are the explanations we’ve been given about the presumed inaccuracy of the CPI.

There is another issue that is not anecdotal at all; it goes to the heart of the conservative passion for cutting the CPI. That is the effect of the CPI on the interest rate. It should be of particular concern to Chairman Alan Greenspan of the Federal Reserve Board. Although he was the first to make a public clamor about the CPI, he seems to be bashful or (maybe) blind to this issue.

Almost always when he’s talking about the interest rate, Mr. Greenspan is careful to make clear whether he’s referring to the money rate or the real rate. When in 1993 he gave up on his attempt to use M2 to forecast the future, moreover, he indicated that the real rate continued to be the object of Reserve policy. The real rate, of course, is the money rate (the rate banks actually charge and we actually pay) less the CPI. Thus if the CPI is overstated by “at least” 1.1 per cent, the Federal Funds rate (the key rate the Reserve sets) is also overstated by at least 1.1 percentage points, as are all other rates.

This should give Mr. Greenspan and the Republican-New Democratic cabal furiously to think. Right now the outstanding debt of nonfinancial sectors of the economy is about $14 trillion. That $14 trillion includes everything from what you owe on your bank credit card through Treasury 30-year bonds. If the CPI is 1.1 per cent too high, the annual interest paid on that $14 trillion is 1.1 percentage points too high-or $154 billion, almost 50 per cent more than the current budget deficit.

Or look at it this way: During the past 10 years, while Alan Greenspan has been keeping the Federal Reserve’s eye trained on the “real” rate of interest, we-you, me, all the businesses of the land, and the city, state, and Federal governments-have paid over $1 trillion too much in interest. We will again pay $1 trillion too much in interest between 1997 and the mystic year of 2002.

Now, the most that any of the Boskin commission expects to gain by cutting the Social Security COLA, modifying the brackets of the income tax, and holding down government and service pensions and disability entitlements seems to be about $200 billion over the next six years. If the commission would just take Mr. Greenspan aside and explain to him how the CPI is overestimated, he could save five times what the commission wants to dock the elderly and disabled.

Not only that: Since he claims to have been aware for a long time of errors in the CPI, he could have made proportionate savings for us at any time in the last decade without bothering the elderly and disabled. The Federal Reserve Board is an independent agency with large staffs of well-paid economists, not only in Washington but also in the 12 district banks. It doesn’t have to base its policies on numbers crunched by the underfunded Bureau of Labor Statistics of the Department of Labor, which computes the CPI, or by the Boskin panel either.

If the Fed were to take a responsible approach to the CPI question, it would sooner or later (depending on how fast they can do simple arithmetic in their heads) come up with a solution that would render irrelevant the Boskin commission’s report and all the debate and talk shows and editorials it has inspired.

BEFORE GETTING DOWN to this solution, let’s make a minor adjustment in nomenclature. I used to talk about the “Bankers’ COLA,” but a friend has complained that the term made unfair fun of bankers; they, after all, are not the only ones to benefit from it. So suppose we now call it the “Fed’s COLA,” because it is the Federal Reserve Board that decides how big the interest rate’s cost-of-living adjustment is.

The simple arithmetic is this: The Federal Reserve Board decides on an estimate of the current rate of change in the CPI, and then adds that estimate-the Fed’s COLA-to the “real” interest rate (which is determined altogether separately) to set the “money” rate. Multiply the outstanding indebtedness of the nonfinancial sectors of the economy by the Fed’s COLA, and you get its cost to the economy.

Next, multiply the Gross Domestic Product by the same rate of change in the CPI (whatever it is). This will give you the cost of inflation to the economy, for that is what the Consumer Price Index is supposed to point to.

Lastly, compare these two costs. In today’s economy it will turn out, no matter what the rate of change in the CPI is, no matter how or by whom calculated or by whom approved, that the Fed’s COLA costs the economy almost twice what inflation costs. The plain and simple reason, as Tom Swiftused to say in a marvelous old series of books for 10-yearolds, is that the outstanding indebtedness of the nonfinancial sectors of the economy is, and has been for many years, almost twice the Gross Domestic Product. So when you multiply them both by the same number, no matter what it is, you get figures that are different by nearly a factor of two.

It doesn’t take Tom Swift to see that if there were no change in the CPI, there would be no Fed’s COLA. Conventional economics, which is perhaps not so smart as Tom Swift, concludes that the thing to do is to get inflation down to zero, whereupon the interest rate could be lowered because the Fed’s COLA would be reduced to zero, too. In order to get inflation down to zero, though, the Federal Reserve Board (which is nothing if not conventional) raises interest rates to control inflation putting us right back where we started from.

Since interest rates are set before things are made, and hence before prices are set, one might rationally expect that the proper procedure would be to get rid of the Fed’s COLA, which (if the estimate of the CPI change is correct) would get rid of inflation as a consequence. And if we got rid of inflation, we could get rid of all the other COLAS. And nobody would be hurt, as people are being hurt today. For a variety of reasons, this could not happen overnight. I’ll name two: First, monetary policy seems to take about two years to have a substantial effect. Second, most existing indebtedness has many years to run. But it shouldn’t take Tom Swift to convince us that we ought not to do the wrong thing just because doing the right thing takes time.